If Your Adviser Didn’t Warn Of Puerto Rico Risk, Replace Him – MMA

By Michael Aneiro

Matt Fabian of Municipal Market Advisors today underscores how widely the muni market had expected Puerto Rico’s downgrade to junk status by calling out any financial advisers who didn’t see it coming and warn their clients:

Puerto Rico’s downgrades provide an excellent opportunity for individual investors to assess the quality of their market professionals. Managers or ﬁnancial advisors who failed to brief their clients on the potential for PR to be downgraded, whether or not they believe a downgrade was warranted, should be considered for replacement. This was a widely discussed risk that aﬀects many thousands of individual investor accounts across the country. Noting the level of post‐downgrade retail bids wanteds and selling, we assume that many investors were simply unprepared for what occurred. The problem, as always, is that most municipal bonds in individual accounts are ultimately overseen by non‐specialist advisors who have only a poor understanding of the risks and granularities involved in municipal lending.

Fabian notes that so far institutional investors haven’t been selling Puerto Rico bonds since the downgrade, with most of the selling that has occurred coming instead from retail investors. He says prices of Puerto Rico bonds won’t necessarily slide further from here, but it’s unclear who would be buying such bonds, particularly if investment-grade funds can’t or won’t buy them anymore. He urges investors to be cautious, and lays out the bull and bear case scenarios for Puerto Rico debt from here:

Bulls contend downgrades were priced in, evidenced by light trading in the aftermath, and that forced fund selling had been exaggerated. The liquidity impact of the downgrades may have been overstated (with extensions of existing liquidity facilities and forbearance of swap terminations a possibility), while fresh liquidity awaits from hedge‐funds, assuming prices are showing satisfactory resilience. The downgrades also present an opportunity for Puerto Rico to adapt to the realities and form new political alliances and enhance ﬁscal practices.

Skeptics are less willing to accept rosy narratives. The juxtaposition of the news of downgrades with the announcement of borrowing sends a message that PR is returning to “business as usual” by presenting a last‐gasp bonding attempt that puts undue pressure on the market. With deep problems, the attempt to borrow at rates approaching double‐digits would, if successful, provides temporary salve but longer term worsens the island’s economic and ﬁscal condition. The issuance would also tap out the Commonwealth’s remaining $1.3B of available borrowing capacity, leaving future leaders with no borrowing capacity.